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Tharp's Thoughts Weekly Newsletter (View On-Line)

January 28, 2009 — Issue #408
  
Article

How Do You Feel About Your Trading? by R.J. Hixson

Trading Education

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Trading Tip

Volatility: The Real “Back Story” in Today’s Market, Part V by D.R. Barton, Jr.

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 Experienced Trader Has More Disciplined Approach

 
 

Feature

How Do You Feel About Your Trading?

by 
R.J. Hixson

 

The other day a friend told me she was having trouble signing a contract because she didn’t feel good about it.  Her comments reminded me of how I felt about my trade entries that morning for one of my systems.  I was still pulling the trigger but wasn’t feeling totally good about it.  The system was performing well, but I’ve started to wonder if these unfamiliar market conditions might affect that system, and I’ve recognized some feelings of slight doubt at the entries. 

Van stresses the critical importance of feelings, emotions, and mental states for traders.  Those aren’t topics to which I paid much attention previously, especially relating to making money in the markets.  By deepening my understanding of this area and following a simple process, my trading has seen a dramatic improvement.

How Do You Feel?

How do you feel right now?  Moreover, how adept are you at identifying and describing how you feel?  Good, fine, or OK?  Those were the core of my emotional vocabulary before doing the Peak Performance Home Study Course and other psychological courses since.  Because we define reality through language, limited vocabulary can effectively limit options, a less than desirable condition when you have the ability to choose.  

Quick test: write down as many descriptive emotional words as you can in one minute.  How many emotions could you list?  I thought I did pretty well coming up with 13 emotions by the one minute point—about the same time I was running out of words.  Then, I turned the page in the book where I found this exercise to see over 300 words listed, and these were just positive emotions!  I felt quite humbled (which, by the way, wasn’t one of my 13 words).  Admittedly, I wasn’t highly conscious of my feelings or able to describe them very well.

To help traders with the common condition of being unconsciousness of their feelings, Van uses a bag of marbles to create a trading simulation game.  It’s partly an emotional laboratory in his workshops.  As the marbles get pulled, the teams respond and the drama ensues.  He’s constantly prodding the players to “Notice your feelings.”  It’s been enlightening to record how emotionally I can react in a simple game involving small amounts of money.  Also watching my teammate’s wild-eyed excitement, frustrated aggravation, or occasional blank-faced despondence has been educational.  Funny, I’ve felt each of those too the way I used to trade. 

That’s the whole point of the game though—to generate emotions, to push your buttons in a controlled environment where you can notice what’s going on inside.  In playing the game multiple times, I’ve experienced a wide range of emotions.  It reminds me of the way I felt when I was trading several years ago. 

The marble game is a powerful experience; ask anyone who’s played.  From it, I’ve learned that clear objectives and preparing a thorough plan can make the game plain fun.  On teams where we have taken these steps, I’ve felt calm, attentive and joyful. 

An Emotionally Driven Process

My emotions used to be driven by what the market was doing.  Volatility was good and smooth periods were bad (it meant waiting patiently or impatiently).  By trying to call market turning points, I would be elated when I caught them or upset when I missed them.  On top of that, my position sizing strategies (or lack thereof) provided another whole level of emotional reactions that compounded my responses to catching or missing the market turns.  Gains engendered larger positions while losses produced seemingly more turning points to trade in my effort to make up some of the losses.  For quite awhile, I actually thought this was working; I was only losing “some” money overall.  When I was about halfway through the Peak Performance course, I started to recognize what was going on.  I had been very lucky not to have blown up my entire account. 

Process Driven Emotions

I was doing nearly nothing like what Van laid out in the Top Tasks of Trading, which were a host of new concepts.  More important for me were some simple fundamentals for successful trading that I could follow: 

1. Having a clear process. 

2. Defining an effective emotional state for each part of the process. 

3. Being able to get into those mental states to trade.  

Wow, this was the most non-technical and radical trading advice I had read since I had decided to “get serious” about trading a few years back.  

The Top Tasks of Trading provided a simple and effective structure to deal with a range of trading issues, including the emotional results of my trading.  Rather than my variable trading results causing variable emotions, the Tasks could help me generate certain emotions in order to create stable trading results.  Furthermore, the Tasks are simple steps that make it easy to identify and address individual trading issues that come up—like my entries last week. 

Ken Long explains that he likes to feel professional when he trades.  That’s an appealing idea for me, and I’ve adopted that as a mental state when I play the marble game as well as when I trade.  The whole idea of picking how I would like to feel when trading was a new idea for me. 

Prescription

To help improve my feelings about my recent entries, last weekend I checked a few things.  Systems results—positive. Big picture—unchanged. The Top Tasks—a very fruitful review.  Several tasks will play a supporting role with my entries this week including a review of my trading system, my ongoing self-analysis, and knowing I have an upcoming periodic review.  One particular task, however, is where getting into a particular mental state will help me a great deal.  It’s the action step where all of the “work” for a trade has been done already and the task is just to enter the position.  I now remember to feel good when I have a valid setup and to enter the trade without thinking.  The mental state for this step is to be totally committed to the entry.  Remembering that little bit will help a lot this week. 

Beyond Trading

Need I mention that if it’s possible to pick a particular mental state to get in to for trading, that it just might be a useful skill for life in general?  It’s funny that working on a “trading skill” also has made my life better.  I like to feel great.  “Feel great” is simply a mental state that I can create now pretty easily instead of waiting for certain things to happen.  Now, do I do that all the time?  Well, no, but that’s called self-sabotage and a whole enchilada for another day. 

How do you want to feel in your trading?  How about a broader question: how do you want to feel in your life?  Wayne Dyer said the plain statement “I want to feel good” can have a profound impact on your thinking. 

Trade well and take care. 

About R.J. Hixson: R.J. Hixson is a devoted husband and active father. He started trading again recently after completing Van Tharp’s Super Trader program and made a full recovery from his previous trading habits. In his spare time, he markets a product line for a global technology company. 

 

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Trading Tip

Volatility: The Real “Back Story” in Today’s Market, 
Part V

by
D. R. Barton, Jr. 

You’ve worked long and hard on picking the right contractor to remodel your kitchen.  You went out for three bids and evaluated them to letter.  In the end, based on a combination of price, quality of past work and referrals, you went with Joe’s Remodeling.

What would you think if on Monday morning, Joe showed up with only a hammer in his tool belt?  You’d probably ask him where the rest of his tools are.  If he replied, “Oh, I only need a hammer," I think you might be a wee bit suspicious that you made the wrong choice for the job.

My good friend and business partner Christopher Castroviejo tells that story at workshops to illustrate the fact that we need to have different tools to do different jobs in the world of trading and investing. The same is true with volatility; there is no one tool that can be used for every job. 

So while we’ve explored Average True Range and VIX (indicators that are very useful) in previous articles, we’ll look at some other tools that we can use.

Volatility – Something Old (Historical) or Something New (Implied)

Two types of volatility are often used together: historical and implied.  The historical variety is just a statistical calculation.  The implied flavor is derived from calculations in a model that predict or estimate the volatility of an instrument for some time in the future (usually 30 days).

Historical volatility can be confusing when trying to understand it mathematically.  Here’s one good definition: historical volatility is calculated by determining the average deviation from the average price of a financial instrument in the given time period.  The statistical measure of standard deviation is most often used for the variability measure.  As a concrete example of this measure of volatility (and its perceived importance), the Chicago Board of Trade lists the following text at the bottom of their “market data” home page:

“Annualized Historical Volatility Formula:  Annualized historical volatility = square root of ( 250 X variance of natural log differences in daily prices for the calendar month).  If reading that made your head spin, don’t worry, you’re not alone!”

Fortunately, if this is a tool you’d like to use, there are many places to get this information that don’t require you to do any math.

If the math for historical volatility can get a tad confusing, then the calculations for implied volatility are pretty indecipherable.   As an amalgam of web definitions, here is a good overview of implied volatility and its usage interpretation: 

Usually, implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets.

Implied volatility is also important because it is used alongside actual data, such as market price, interest rates, expiration date, and strike price to calculate an option's premium.

Complex options price models, such as the Black-Scholes Model, are typically used to calculate implied volatility.

How Are These Mathematical Abominations Used?

Broadly, there are a couple of main uses for historical and implied volatility.  In options trading, the two are frequently compared to each other to determine if options are currently over- or under-valued.  As you can imagine, traditional relationships between these values have been way out of whack for months now.

In the book Street Smarts by Conners and Raschke, a trading strategy is described that uses relative historical volatility as an entry signal.  They compare long-term historical volatility (100 day) to very short term volatility (6 day) to look for volatility contractions.  Their requirement for the short term volatility to be 50% or less of the longer term volatility is another measure that has required some serious revision in these times of high volatility (although you could just accept fewer or no signals until volatility quiets down to historical levels again).

Next week we’ll look at more tools to add to our volatility toolbox.  Until then…

Great Trading,

D. R.

About D.R. Barton:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”. 

D.R. is presenting the  How to Develop a Winning Trading System That Fits You Workshop, this weekend. 

Mailbag

Experienced Trader Has More Disciplined Approach

In this new section, we'll share comments from readers. We encourage you to click below if you have feedback to submit for Dr. Tharp. 

Hi Van,

We met in Singapore last year at your Systems Development Workshop. I hope you're doing fine. I always read your thoughts with pleasure. 

Despite 10 years of experience, you actually opened my eyes to a new way of trading; more clever and disciplined than before. I really reconfigured my mental attitudes. I've done a lot of work after the seminar (lots of reading, research, ...) and now I really feel ready. I have written a clear plan and apply it successfully for the bank. Of course, I keep on digging in research.

Life is short. So by the end of this year, I have the intention to make my dream come true... I'm well prepared now!

Best wishes of happiness for 2009,
Cheers,
Marc 

 

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Copyright 2008 the International Institute of Trading Mastery, Inc.

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